Law Times

PAGE 10 FOCUS February 6, 2012 • Law Times BY JULIUS MELNITZER For Law Times into force on Dec. 15, 2008, it contained several significant and W hen the fifth protocol to the Canada-United States Income Tax Convention came highly anticipated changes to the treaty. Below the radar, how- ever, were some minor amend- ments, many of which observers brushed off as little more than clarifications. Irritations, however, might have been a better description, especially in the case of the changes to Article XV. "There is evidence that some auditors of the Internal Revenue Service are interpreting this amendment in a manner that goes beyond what was intended by trea- ty negotiators," says Jim Wilson of Gowling Lafleur Henderson LLP. "If this signals the beginning of a trend, it could have major rami- fications on cross-border services, particularly intragroup services where Canadian employees are sent to work in the U.S. for a short period of time." Article XV deals with exemp- tions from tax on remunera- tion earned by an employee of a Canadian or U.S. company with respect to duties exercised in the other jurisdiction, which is known as the source country. Previously, Article XV exempted income earned in the source When it comes to IP in Canada, We're Well Read Ridout & Maybee LLP: Editors of the Canadian Patent Reporter it all starts somewhere www.ridoutmaybee.com country where the remuneration wasn't borne by an employer resident there. The amendment substituted the word person for employer. According to Wilson, the change has caused unintended dif- ficulties. "If the tax authorities read the amended provision literally — which they shouldn't be doing — the change creates a lot of uncertainty as to when source states will have taxing rights on employees earning money from performing duties in their coun- tries," he says. Such a reading, however, doesn't accord with the technical explanation accompanying the protocol. It states that the change was intended "only to clarify that both the United States and Canada understand that in cer- tain abusive cases, substance over form principles may be applied to characterize an employment rela- tionship." Similarly, the Canada Revenue Agency has stated that the intention of the change was "to determine, who, in fact, is exercis- ing the functions of employer." Wilson posits the case of employed by a an individual Canadian parent who occasion- Untitled-1 1 12-01-23 9:05 AM MAP THE CORRECT COURSE OF ACTION FOR CROSS-BORDER LITIGATION CROSS-BORDER LITIGATION: INTERJURISDICTIONAL PRACTICE AND PROCEDURE KENNETH C. MacDONALD Cross-Border Litigation: Interjurisdictional Practice and Procedure provides guidance on all aspects of cross-border litigation. It will help you better understand the legal considerations involved, such as: • • • • • • • • • ORDER # 804484 $126 Hardcover 424 pages May 2009 978-0-88804-484-6 Shipping and handling are extra. 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AVAILABLE RISK-FREE FOR 30 DAYS Order online at www.carswell.com Call Toll-Free: 1-800-387-5164 In Toronto: 416-609-3800 CANADA LAW BOOK® www.lawtimesnews.com ally goes to the United States to assist a subsidiary. The arrange- ment isn't in the nature of a sec- ondment or employee sharing and is purely a contract of ser- vices between the parent and the subsidiary. The subsidiary reim- burses the parent for the cost. "Assume that the employees of the parent spend less than 90 days in the U.S. each year but do earn more than the exempt threshold of US$10,000," says Wilson. "Assume also that the parent also does not have a permanent establishment in the U.S, which would constitute another basis for taxation." According to Wilson, the individual is exempt from U.S. income tax on the U.S. duties before the amendment because the subsidiary bearing the cost of the remuneration wasn't the employer. But the new wording leaves open the interpretation that the subsidiary that bore that cost was a person resident in the United States. "The upshot is that the IRS is challenging some Canadian residents who are employees of Canadian companies on their claims for treaty benefits under Article XV," says Wilson. "That treatment is inconsistent with the technical explanation or the CRA announcement on this topic, as well as with the application of Article XV before the amend- ment." Quite apart from the impact on employees, the impugned inter- pretation would almost certainly increase the administrative burden and costs for the employer. "Employees could be required to file tax returns and compa- nies could be required to make source deductions in both coun- tries, causing significant account- ing and payroll costs," says Patrick Marley of Osler Hoskin & Harcourt LLP. But there are some steps that Canadian companies can take to boost their employees' position with the IRS. "I'm recommending that the company and the employee pre- pare contemporaneous documen- tation that makes it clear that the employees are being sent to the U.S. on a short-term basis, that they are taking instructions from the parent, and that no risk or reward is flowing from the subsid- iary," says Wilson. To implement these measures, companies could have their tax advisers prepare questionnaires aimed at highlighting the common law characteristics of what makes an individual an employee. "When the auditor comes around, the employee and the company should have both the documentation and the techni- cal explanation at the ready," says Wilson. If discussions with the auditor don't work, two avenues of poten- tial relief remain. "The employee or company can resort to tax courts in either country or seek relief through the binding arbitration mechanism in the tax treaty that is designed to get the tax authorities in both countries to adopt a com- mon view of an issue." LT T ax treaty update includes irritations

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